Deck 10: Estimating Risk and Return

Question 1

Which of the following is the use of debt to increase an investment position?

A)behavioral finance
B)financial leverage
C)probability
D)stock market bubble

Answer 1

financial leverage

Question 2

Which of these is the measurement of risk for a collection of stocks for an investor?

A)beta
B)efficient market
C)expected return
D)portfolio beta

Answer 2

portfolio beta

Question 3

In theory, which of these is a combination of securities that places the portfolio on the efficient frontier and on a line tangent from the risk-free rate?

A)efficient market
B)market portfolio
C)probability distribution
D)stock market bubble

Answer 3

market portfolio

Question 4

Which of the following are the stocks of small companies that are priced below $1 per share?

A)bargain stocks
B)hedge fund stocks
C)penny stocks
D)stock market bubble stocks

Question 5

Which of these is the reward for taking systematic stock market risk?

A)required return
B)risk-free rate
C)risk premium
D)market risk premium

Question 6

Which of the following is the asset pricing theory based on a beta, a measure of market risk?

A)behavioral asset pricing model
B)capital asset pricing model
C)efficient markets asset pricing model
D)efficient market hypothesis

Question 7

Which of these is similar to the Capital Market Line, except that risk is characterized by beta instead of standard deviation?

A)market risk line
B)probability market line
C)security market line
D)stock market line

Question 8

Which of these refers to something that has not been released to the public, but is known by few individuals, likely company insiders?

A)audited financial statements
B)restricted stock
C)privately held information
D)insider trading

Question 9

Which of the following is NOT a necessary condition for an efficient market?

A)many buyers and sellers
B)no prohibitively high barriers to entry
C)free and readily available information available to all participants
D)no trading or transaction costs

Question 10

Which of the following is a model that includes an equation that relates a stock's required return to an appropriate risk premium?

A)asset pricing
B)behavioral finance
C)beta
D)efficient markets

Question 11

Which of the following is typically considered the return on U.S. government bonds and bills and equals the real interest plus the expected inflation premium?

A)required return
B)risk-free rate
C)risk premium
D)market risk premium

Question 12

Which of the following is the reward investors require for taking risk?

A)required return
B)risk-free rate
C)risk premium
D)market risk premium

Question 13

Which of these is the set of probabilities for all possible occurrences?

A)probability
B)probability distribution
C)stock market bubble
D)market probabilities

Question 14

Which of these is the line on a graph of return and risk (standard deviation) from the risk-free rate through the market portfolio?

A)capital asset pricing line
B)capital market line
C)efficient market line
D)efficient market hypothesis

Question 15

Which of the following is data that includes past stock prices and volume, financial statements, corporate news, analyst opinions, etc.?

A)audited financial statements
B)generally accepted accounting principles
C)privately held information
D)public information

Question 16

Which of the following is the average of the possible returns weighted by the likelihood of those returns occurring?

A)efficient return
B)expected return
C)market return
D)required return

Question 17

Which of these is a theory that describes the types of information that are reflected in current stock prices?

A)asset pricing
B)behavioral finance
C)efficient market hypothesis
D)public information

Question 18

Which of these is a measure of the sensitivity of a stock or portfolio to market risk?

A)behavioral finance
B)beta
C)efficient market
D)hedge

Question 19

Which of the following is a true statement?

A)The risk and return that a firm experienced in the past is also the risk level for its future.
B)Firms can quite possibly change their stocks' risk level by substantially changing their business.
C)If a firm takes on riskier new projects over time, the firm itself will become less risky.
D)If a firm takes on less risky new projects over time, the firm itself will become more risky.

Question 20

Investor enthusiasm causes an inflated bull market that drives prices too high, ending in a dramatic collapse in prices is known as

A)behavior finance.
B)efficient market.
C)privately held information.
D)stock market bubble.

Question 21

A company's current stock price is $84.50 and it is likely to pay a $3.50 dividend next year. Since analysts estimate the company will have a 10 percent growth rate, what is its expected return?

A)4.14 percent
B)4.26 percent
C)10.00 percent
D)14.14 percent

Question 22

A company has a beta of 4.5. If the market return is expected to be 14 percent and the risk-free rate is 7 percent, what is the company's risk premium?

A)7.0 percent
B)25.5 percent
C)31.5 percent
D)38.5 percent

Question 23

Compute the expected return given these three economic states, their likelihoods, and the potential returns: Economic State
Probability
Return
Fast Growth
0)3
40%
Slow Growth
0)4
15%
Recession
0)3
-15%

A)13.5 percent
B)22.5 percent
C)18.3 percent
D)40.0 percent

Question 24

The annual return on the S&P 500 Index was 18.1 percent. The annual T-bill yield during the same period was 6.2 percent. What was the market risk premium during that year?

A)6.2 percent
B)11.9 percent
C)18.1 percent
D)24.3 percent

Question 25

A company has a beta of 2.91. If the market return is expected to be 16 percent and the risk-free rate is 4 percent, what is the company's risk premium?

A)11.64 percent
B)12.00 percent
C)22.91 percent
D)34.92 percent

Question 26

If the risk-free rate is 10 percent and the market risk premium is 4 percent, what is the required return for the market?

A)4 percent
B)7 percent
C)10 percent
D)14 percent

Question 27

A company has a beta of 0.50. If the market return is expected to be 12 percent and the risk-free rate is 5 percent, what is the company's required return?

A)6.0 percent
B)8.5 percent
C)11.0 percent
D)13.5 percent

Question 28

The constant growth model assumes which of the following?

A)that there is privately held information
B)that the stock is efficiently priced
C)that there are executive stock options available to managers
D)that there is no restricted stock

Question 29

Compute the expected return given these three economic states, their likelihoods, and the potential returns: Economic State
Probability
Return
Fast Growth
0)1
50%
Slow Growth
0)6
8%
Recession
0)3
-10%

A)6.8 percent
B)12.8 percent
C)16.0 percent
D)22.7 percent

Question 30

If the NASDAQ stock market bubble peaked at 3,750, and two and a half years later it had fallen to 2,200, what would be the percentage decline?

A)(-15.87 percent)
B)(-17.05 percent)
C)(-41.33 percent)
D)(-58.67 percent)

Question 31

A company has a beta of 3.75. If the market return is expected to be 20 percent and the risk-free rate is 9.5 percent, what is the company's required return?

A)33.250 percent
B)39.375 percent
C)48.875 percent
D)55.625 percent

Question 32

The study of the cognitive processes and biases associated with making financial and economic decisions is known as

A)asset pricing model.
B)behavioral finance.
C)efficient market hypothesis.
D)stock market bubble.

Question 33

You have a portfolio with a beta of 1.25. What will be the new portfolio beta if you keep 80 percent of your money in the old portfolio and 20 percent in a stock with a beta of 1.75?

A)1.00
B)1.35
C)1.50
D)3.00

Question 34

The annual return on the S&P 500 Index was 12.4 percent. The annual T-bill yield during the same period was 5.7 percent. What was the market risk premium during that year?

A)5.7 percent
B)6.7 percent
C)12.4 percent
D)18.1 percent

Question 35

Shares of stock issued to employees that have limitations on when they can be sold are known as

A)executive stock options.
B)privately held information.
C)restricted stock.
D)stock market bubble.

Question 36

If the Japanese stock market bubble peaked at 37,500, and two and a half years later it had fallen to 25,900, what was the percentage decline? t

A)(-10.31 percen)
B)(-27.63 percent)
C)(-30.93 percent)
D)(-69.07 percent)

Question 37

A company has a beta of 3.25. If the market return is expected to be 14 percent and the risk-free rate is 5.5 percent, what is the company's required return?

A)22.750 percent
B)33.125 percent
C)45.500 percent
D)51.000 percent

Question 38

You have a portfolio with a beta of 0.9. What will be the new portfolio beta if you keep 40 percent of your money in the old portfolio and 60 percent in a stock with a beta of 1.5?

A)1.00
B)1.20
C)1.26
D)2.40

Question 39

If the risk-free rate is 8 percent and the market risk premium is 2 percent, what is the required return for the market?

A)2 percent
B)6 percent
C)8 percent
D)10 percent

Question 40

Special rights given to some employees to buy a specific number of shares of the company stock at a fixed price during a specific period of time are known as

A)executive stock options.
B)privately held information.
C)restricted stock.
D)stock market bubble.

Question 41

Compute the standard deviation of the expected return given these three economic states, their likelihoods, and the potential returns: Economic State
Probability
Return
Fast Growth
0)2
30%
Slow Growth
0)5
6%
Recession
0)3
-2%

A)8.4 percent
B)10.87 percent
C)11.34 percent
D)24.09 percent

Question 42

Compute the standard deviation given these four economic states, their likelihoods, and the potential returns: Economic State
Probability
Return
Fast Growth
0)35
40%
Slow Growth
0)45
10%
Recession
0)10
-10%
Depression
0)10
-100%

A)7.5 percent
B)12.65 percent
C)39.48 percent
D)113.69 percent

Question 43

Netflix, Inc. has a beta of 3.61. If the market return is expected to be 13.2 percent and the risk-free rate is 7 percent, what is Netflix's risk premium?

A)20.91 percent
B)22.38 percent
C)25.72 percent
D)29.38 percent

Question 44

You own $2,000 of City Steel stock that has a beta of 2.5. You also own $8,000 of Rent-N-Co (beta = 1.9) and $4,000 of Lincoln Corporation (beta = 0.25). What is the beta of your portfolio?

A)1.51
B)1.55
C)4.65
D)14.00

Question 45

You have a portfolio with a beta of 3.1. What will be the new portfolio beta if you keep 85 percent of your money in the old portfolio and 15 percent in a stock with a beta of 4.5?

A)3.31
B)3.51
C)3.61
D)3.71

Question 46

A manager believes his firm will earn a 16 percent return next year. His firm has a beta of 1.5, the expected return on the market is 14 percent, and the risk-free rate is 4 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is undervalued or overvalued.

A)19 percent, undervalued
B)19 percent, overvalued
C)22 percent, undervalued
D)22 percent, overvalued

Question 47

You hold the positions in the following table. If you expect the market to earn 14 percent and the risk-free rate is 5 percent, what is the required return of the portfolio? Price Shares Beta
Website.com
$20)50 100 3.2
Budget Stores
$36)20 150 1.5
Manufacturing Corp.
$60)70 75 2.4
Pharmacy Corp.
$28)40 200 0.75

A)20.21 percent
B)22.66 percent
C)28.66 percent
D)32.48 percent

Question 48

Compute the standard deviation given these four economic states, their likelihoods, and the potential returns: Economic State
Probability
Return
Fast Growth
0)20
100%
Slow Growth
0)50
10%
Recession
0)20
-1%
Depression
0)10
-10%

A)12.19 percent
B)23.8 percent
C)38.65 percent
D)88.06 percent

Question 49

The average annual return on the S&P 500 Index from 1986 to 1995 was 17.6 percent. The average annual T-bill yield during the same period was 9.8 percent. What was the market risk premium during these 10 years?

A)8.2 percent
B)7.8 percent
C)8.8 percent
D)9.8 percent

Question 50

The Nasdaq stock market bubble peaked at 10,816 in 2000. Two and a half years later it had fallen to 4,000. What was the percentage decline?

A)(-63.02%)
B)(-69.47%)
C)(-57.13%)
D)(-49.18%)

Question 51

You own $1,000 of City Steel stock that has a beta of 1.5. You also own $5,000 of Rent-N-Co (beta = 1.8) and $4,000 of Lincoln Corporation (beta = 0.9). What is the beta of your portfolio?

A)1.4
B)1.5
C)4.2
D)4.65

Question 52

Compute the expected return given these three economic states, their likelihoods, and the potential returns: Economic State
Probability
Return
Fast Growth
0)2
23%
Slow Growth
0)6
14%
Recession
0)2
-30%

A)3.5 percent
B)7.0 percent
C)7.5 percent
D)12.5 percent

Question 53

Compute the standard deviation of the expected return given these three economic states, their likelihoods, and the potential returns: Economic State
Probability
Return
Fast Growth
0)1
50%
Slow Growth
0)6
8%
Recession
0)3
-10%

A)6.8 percent
B)16.5 percent
C)21.5 percent
D)46.4 percent

Question 54

A manager believes his firm will earn a 12 percent return next year. His firm has a beta of 1.2, the expected return on the market is 8 percent, and the risk-free rate is 3 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is undervalued or overvalued.

A)9 percent, undervalued
B)9 percent, overvalued
C)13.8 percent, undervalued
D)13.8 percent, overvalued

Question 55

A company's current stock price is $65.40 and it is likely to pay a $2.25 dividend next year. Since analysts estimate the company will have an 11.25 percent growth rate, what is its expected return?

A)3.44 percent
B)3.61 percent
C)11.25 percent
D)14.69 percent

Question 56

You hold the positions in the following table. What is the beta of your portfolio? Price Shares Beta
TechNo Comp.
$15)25 2000 4.0
Delivery Corp.
$105.00 500 1.4
Computer Corp.
$35)40 300 0.9
Food Corp.
$18)75 200 0.7

A)1.4
B)2.08
C)2.13
D)5.6

Question 57

You own $5,000 of Software Corp's stock that has a beta of 3.75. You also own $10,000 of Home Improvement Corp. (beta = 1.5) and $15,000 of Publishing Corp. (beta = 0.35). Assume that the market return will be 13 percent and the risk-free rate is 4.5 percent. What is the risk premium of the portfolio?

A)11.05 percent
B)16.50 percent
C)17.00 percent
D)24.70 percent

Question 58

Compute the standard deviation given these four economic states, their likelihoods, and the potential returns: Economic State
Probability
Return
Fast Growth
0)40
50%
Slow Growth
0)40
10%
Recession
0)10
-10%
Depression
0)10
-5%

A)6.71 percent
B)22.5 percent
C)23.37 percent
D)52.20 percent

Question 59

A manager believes his firm will earn a 7.5 percent return next year. His firm has a beta of 2, the expected return on the market is 5 percent, and the risk-free rate is 2 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is undervalued or overvalued.

A)8 percent, undervalued
B)8 percent, overvalued
C)12 percent, undervalued
D)12 percent, overvalued

Question 60

Hastings Entertainment has a beta of 1.24. If the market return is expected to be 10 percent and the risk-free rate is 4 percent, what is Hastings' required return?

A)11.44 percent
B)12.44 percent
C)14.96 percent
D)16.40 percent

Question 61

Which of the following statements is correct?

A)If the market is strong-form efficient it must also be weak-form efficient and semi-strong efficient.
B)There is evidence to suggest that the market is strong-form efficient because corporate insiders have made extraordinary profits by trading on inside information.
C)The Efficient Market Hypothesis states that security prices will be based on their expected return.
D)none of these choices are complete.

Question 62

IBM's stock price is $22, it is expected to pay a $2 dividend, and analysts expect the firm to grow at 10 percent per year for the next five years. TDI's stock price is $10, it is expected to pay a $1 dividend, and analysts expect the firm to grow at 12 percent per year for the next five years. What is the difference in the two firms' required rates of return?

A)2.91 percent
B)1.82 percent
C)2.03 percent
D)3.23 percent

Question 63

You hold a diversified portfolio consisting of $1,000 investment in each of 10 different stocks. The portfolio has a beta of 0.8. You have decided to sell one of your stocks that has a beta equal to 1.1 for $1,000. You will purchase $1,000 of a new stock with a beta of 2.5. After these two transactions (sell and buy), what will be the beta of the new portfolio?

A)1.1
B)0.99
C)0.87
D)0.94

Question 64

Stock A has a required return of 19 percent. Stock B has a required return of 11 percent. Assume a risk-free rate of 4.75 percent. By how much does Stock A's risk premium exceed the risk premium of Stock B?

A)3.25 percent
B)6.25 percent
C)8.00 percent
D)7.00 percent

Question 65

You hold the positions in the following table. What is the beta of your portfolio? If you expect the market to earn 12 percent and the risk-free rate is 3.5 percent, what is the required return of the portfolio? Price Shares Beta
Amazon.com
$40 100 3.8
Family Dollar Stores
$30 100 1.2
McKesson Corp.
$50 100 0.4
Schering-Plough Corp.
$20 100 0.5

A)14.21 percent
B)16.76 percent
C)13.97 percent
D)15.38 percent

Question 66

You own $10,000 of Denny's Corp. stock that has a beta of 3.2. You also own $15,000 of Qwest Communications (beta = 1.9) and $15,000 of Southwest Airlines (beta = 0.4). Assume that the market return will be 13 percent and the risk-free rate is 5.5 percent. What is the risk premium of the portfolio?

A)10.51 percent
B)11.49 percent
C)12.45 percent
D)13.62 percent

Question 67

Compute the expected return and standard deviation given these four economic states, their likelihoods, and the potential returns: Economic State
Probability
Return
Fast Growth
0)20
60%
Slow Growth
0)50
13%
Recession
0)15
-15%
Depression
0)15
-45%

A)9.5 percent; 32.43 percent
B)9.5 percent; 21.96 percent
C)9.5 percent; 18.97 percent
D)9.5 percent; 29.18 percent

Question 68

Stock A has a required return of 12 percent. Stock B has a required return of 15 percent. Assume a risk-free rate of 4.75 percent. Which of the following is a correct statement about the two stocks?

A)Stock A is riskier.
B)Stock B is riskier.
C)The stocks have the same risk.
D)We would need to know if the markets are efficient to answer this question.

Question 69

Which of the following is correct?

A)Hedge funds often sell stock they don't even own.
B)Hedge funds maintain secrecy about their holdings, trading, and strategies.
C)Hedge funds are limited to sophisticated investors.
D)All of these choices are correct.

Question 70

Praxair's upcoming dividend is expected to be $2.25 and its stock is selling at $65. The firm has a beta of 0.8 and is expected to grow at 10 percent for the foreseeable future. Compute Praxair's required return using both CAPM and the constant growth model. Assume that the market portfolio will earn 10 percent and the risk-free rate is 3 percent.

A)CAPM: 8.6 percent; Constant Growth Model: 13.46 percent
B)CAPM: 9.7 percent; Constant Growth Model: 12.56 percent
C)CAPM: 10.1 percent; Constant Growth Model: 11.46 percent
D)CAPM: 8.2 percent; Constant Growth Model: 9.56 percent

Question 71

ABC Inc. has a dividend yield equal to 3 percent and is expected to grow at a 7 percent rate for the next seven years. What is ABC's required return?

A)10 percent
B)11 percent
C)4 percent
D)5 percent

Question 72

You own $9,000 of Olympic Steel stock that has a beta of 2.5. You also own $7,000 of Rent-a-Center (beta = 1.2) and $8,000 of Lincoln Educational (beta = 0.4). What is the beta of your portfolio?

A)1.18
B)1.07
C)1.42
D)1.53

Question 73

IBM has a beta of 1.0 and Apple Computer has a beta of 3.0. Which of the following statements must be correct?

A)The market risk premium for Apple must be larger than the market risk premium of IBM.
B)If investors become more risk averse, the expected return of Apple will increase more than the expected return on IBM.
C)Apple's expected rate of return must be three times as large as IBM's.
D)none of these choices are complete.

Question 74

A manager believes his firm will earn an 18 percent return next year. His firm has a beta of 1.75, the expected return on the market is 13 percent, and the risk-free rate is 5 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is under-valued or over-valued.

A)19 percent; overvalued
B)19 percent; undervalued
C)16.7 percent; overvalued
D)16.7 percent; undervalued

Question 75

Paccar's current stock price is $75.10 and it is likely to pay a $3.29 dividend next year. Since analysts estimate Paccar will have a 14.2 percent growth rate, what is its required return?

A)15.39 percent
B)17.94 percent
C)18.58 percent
D)19.62 percent

Question 76

Which of the following statements is incorrect?

A)The capital market line shows the relationship between return and risk as measured by the standard deviation.
B)The Efficient Market Hypothesis states that security prices fully reflect all available information.
C)The security market line shows the relationship between return and risk as measured by beta.
D)none of these choices are complete.

Question 77

Which of the following is incorrect?

A)Technical analysis is expected to work if markets are weak-form efficient.
B)If markets are strong-form efficient then they must also be weak-form efficient.
C)It is not likely that the market is strong-form efficient.
D)none of these choices are complete.

Question 78

You hold the positions in the following table. What is the beta of your portfolio? If you expect the market to earn 10 percent and the risk-free rate is 4 percent, what is the required return of the portfolio? Price Shares Beta
Advanced Micro Devices
$10 200 4.2
FedEx Corp.
$100 50 1.1
Microsoft
$30 150 0.7
Sara Lee Corp.
$15 200 0.5

A)12.37 percent
B)9.73 percent
C)10.17 percent
D)11.68 percent

Question 79

Stock A has a required return of 19 percent. Stock B has a required return of 11 percent. Assume a risk-free rate of 4.75 percent. Which of the following is a correct statement about the two stocks?

A)Stock A is riskier.
B)Stock B is riskier.
C)The stocks have the same risk.
D)We would need to know if the markets are efficient to answer this question.

Question 80

U.S. Bancorp holds a press conference to announce a positive news event that was unexpected to the market. As soon as the announcement is made, the stock price increases $8 per share but then over the next hour the price continues to increase resulting in a total increase of $11. Given this information which of the following statements is correct?

A)This is an example of a market overreaction.
B)This is an example of a market underreaction.
C)This is an example of a semi-strong efficient market.
D)none of these choices are complete.